Admittedly, the report from Emirates Business 24/7 (hat tip reader Michael) is only one expert’s opinion, but it focuses on an issue that hasn’t gotten the attention it warrants, namely, the level of the current oil glut and how much it is going to take to work it down. The subtext of this piece is that absent a pickup in oil demand, it is going to take quite a lot of discipline among OPEC members, far more than they have exhibited to date, to get oil prices to a presumed target level of $75 a barrel.

From Emirates Business 24/7:

A prominent Arab energy analyst has blamed Opec for the collapse in crude prices, saying the oil cartel has failed to fully comply with output cuts and kept sending contradicting messages to the already sceptic market.

Nicholas Sarkis, Director General of the Paris-based Arab Petroleum Research Centre (APRC), which acts as an adviser to the Organisation of Arab Petroleum Exporting Countries (Oapec), described Opec’s behaviour in dealing with the faltering crude demand over the past few months as “suicidal.”

In an article published in the APRC’s monthly magazine, Arab Oil and Gas, Sarkis urged the 12-nation Opec to announce a target for its oil price and to abide by output reductions to attain it…..

“For the third time in a row, the latest meeting held on December 17 had the immediate impact not of bringing about the hoped-for rebound in prices but of speeding up their collapse, so much so that the monthly average value of the Opec crude basket fell from $112.4 in August, the month preceding the first of these Opec gatherings in September, to $49.7 in November and an average of $34.9 in the week that followed the December meeting,” he said.

“At first sight, this calamitous outcome may seem particularly surprising insofar as the organisation decided in the meantime to implement relatively large cuts in production, reducing output by a total of 4.2 million bpd from January 1.”

Sarkis cited three main reasons for Opec’s failure to prevent the price crash including the fact that the latest reductions remained ink on paper until January 1 and the previous cut of 1.5 million bpd was not fully enforced, with the rate of compliance by its members not exceeding 55 per cent.

Yves here. Note that that level of compliance is far below what we have seen claimed elsewhere, but is consistent with Nigeria complaining about cheating prior to the last OPEC meeting. Back to the article:

He said the second reason is that the surplus of supply on the world market has led to a sharp increase in industry stocks in industrialised countries, which reached an estimated level of fully 2,707 million barrels at the end of November, equivalent to more than 57 days of forward consumption, or five days more than the average of 52 days that are regarded as “normal”.

He noted that the level of stocks corresponds to double the annual output of Iran and to more than five times the production of Algeria….

“Just to return to a level of stocks that can be regarded as more normal, which is to say to soak up a stock surplus corresponding to five days’ consumption, or some 240 million barrels, Opec countries would now have to start applying absolutely strictly the cumulative reduction in output of 4.2 million bpd for a period of nearly two months, provided, of course, that world demand did not decline further, especially in the run-up to next spring, when world needs could decline by 0.9-1 million bpd relative to the first quarter of 2009,” he said.

“A third reason, but by no means the least, for the failure of Opec decisions is the widespread scepticism with which they were greeted by the oil markets. That scepticism is attributable first and foremost to the partial compliance with the 1.5-million bpd cut in that was due to take effect on November 1….”

According to Sarkis, several official communiqués released by Opec over the past few months “curiously omit to give an exact figure for the desired level of prices and a clear road map for getting there”. He said things would certainly have been different if exporting countries had decided at their last three conferences simply to return to the system in use before the war in Iraq in March 2003, “which entailed setting a floor price and a ceiling price for their exports”, as well as implementing automatic, precise reductions and increases in production to attain their ends.

In the current circumstances, he added, the price of $75/b that is regarded as desirable by Saudi Arabia and many others represents a good average of the figures that have been more or less explicitly suggested by various officials in both exporting countries and industrialised nations.

“Restoring oil prices to a level of at least $75 seems that much more necessary insofar as an almost unanimous consensus is evident on both sides about the fact that the level to which oil prices have fallen can only discourage investments both in the hydrocarbon industry and in those involving the development of other energy sources, ” Sarkis said….

“As far as a possible recovery in oil prices is concerned, we will now have to wait and see the full scale of the cuts in production implemented in both Opec and non-Opec countries. Another positive factor could be acceleration in the closure of wells and small fields that have become unprofitable in the current environment, especially in North America.”

17 comments

Occam’s Razor argues it is more likely that oil derivatives and the credit crisis caused price volatility to exceed the speed limit of political action. It’s the simplest explanation.

It takes time for a dozen sovereign nations to do just about anything, even if they face a certain catastrophe. (Consider the 15 years we’ve spent doing almost nothing about loose nukes.)

In this case, when a teapot dictator decides to spend as if oil will always be $90, it may take some time for him to accept a new reality. Singapore excepted, authoritarian governments don’t make decisions efficiently (look at Bush).

Hopeless hope may have caused hesitation, and only a little hesitation was needed for a price collapse.

It’s not just OPEC. Our entire global economy, in some sense, is a bunch of mirror images of the OPEC problem: there’s tremendous overcapacity in resources, transportation, cars, general manufacturing, and most industries you can imagine.

At the same time, every individual state or corporation has an incentive to continue producing as long as it’s marginally profitable(and sometimes after that). This incentive is being actively fueled as cash flow dwindles.

The chip industry is my favorite example. The collapse of South Korea will make them as desperate as, say, Russia is to export oil. The collapse of the won will make it very cheap for them to sell overseas. Basically, the collapse of South Korea has created an incredibly hungry, desperate, and cheap competitor for a large swath of consumer electronics.

If OPEC, with a finite and dear resource, is unable to achieve unity, our newly nationalized global car manufacturers, the chipmakers, and others will shred each other. Margins and prices will continue to collapse in many, many sectors.

How about we place the blame where we should, with the collapse of Lehman. Lehman’s collapse caused massive deleveraging, which ended the run away inflation caused by Bernanke and Geithners excessive interest rate cuts while we were still experiencing economic growth.

Inflation is always and everywhere a monetary function, and the same holds true for deflation.

Price rise and fall in reaction to supply and demand, not to external factors such as speculation.

Speculators may have ridden a wave of a shortage but as soon as oil producers of all types increase their production, it is supply, not bets on what would happen with the supply which will affect the outcome.

Oil ain’t like equities. It is consumed at some point in the bidding process.

In theory, not practice finite-ness is a characteristic of oil, but the reality is that oil is being discovered all the time.

So the fevered realization of peak oil will remain for the foreseeable future, just that: a fevered scenario which has yet to play out, and may well never play out in our lifetimes.

there was a blurb in a rag a while ago about how “poorer” OPEC countries were cribbing about reducing production any further due to profit margins. maybe there will be an OPEC bailout one of these days.

This oil pricing thing smells of corruption. Before Bush Admin hardly a peep about oil. In the last eight years it is all we talk about.

I saw $4.40/gallon gas here in California when oil was $140/barrel, now that it is at $40/barrel gas here is $2.00/barrel???

The state of Texas was running a surplus? The City of Houston still is. What do you think built Dubai (hint; manipulated oil prices). If you knew high priced oil would follow Bush presidency – sound advise; build lack mad, create next Las Vegas. When oil market comes back Dubai will be a ghost town. No real centers of commerce near it. A great folly of corruption.

Oil firms were profitable at less than $20/barrel, so common sense says real costs are a good deal less than $20/barrel. When they got to $140 costs did not change. Huge siphoning of money from American economy (those funds built Dubai and were aggregated in Saudi sovereign funds to purchase American equities). Enormous thieving.

And we think finance are the real king pins of this corruption decade. A joke. Oil used all available means to steal (patriotism, military, fear, executive branch, etc). Obama was intuitive in his inaugural address by mentioning “childish behavior”. We are not mature enough to posses such a magnanimous military machine.

Paternal logic says more financial pain is required for the “child” to be punished and behavior modified to insure an adult life to enjoy. We will see.

Regardless of what caused the oil price rise and here I would look closely at fixed retail prices in India and China as a cause, the question must be who in OPEC is not complying. Libya, Venezuela. Algeria and Iran would appear to be candidates and of those Libya seems to be the prime candidate from recent data I have seen yet we know that instructions have been specifically given to cut even more than the quota requires.

The question then remains if OPEC members are complying, did OPEC cut the quotas enough and I think the answer is probably not with Chinese purchases significantly down. The matter is also complicated by oil stock piles for the Olympics that china needs to work through and the fact that shipping problems earlier in the year lead to oil storage on ships which also needs to be worked through.

Looking into the crystal ball you would have to say it will be at least 6 months before stockpiled oil can be worked through and in the mean time oil producers are likely to suffer some significant economic damage. Perhaps countries like Russia and Venezuela will be on the verge of a depression as a result. In the second half of this year an oil price recovery is possible further squeezing consumers and slowing any recovery.

Longer term with almost no investment in producing more capacity to produce oil then we should expect oil prices to go through the roof when t capacity is fulling utlized again. A period of peak oil ($300 a barrel)_ looks likely to stop any recovery in its tracks some 2 to 3 years down the road as a result.

OPEC needs to drop this $75 target nonsense. If you look at historical oil prices in current dollars from the end of WWII to today, and remove the mid/late 1970’s embargo period and the late 90’s oil collapse, you’ll see that oil has traded between $20-$40 in todays dollars for almost all of modern history.

How many billions were poured into commodities by traders in Jan 2008? Not a word here about that – how soon we forget. I believe oil busted this economy. In 2005 I had to make a decision about keep my house or sell it because everything was going up and up. I sold my house and took my equity and bought a 1920 fixerupper( no mortgage ) Inflation has never been this bad . Everthing from food to utilities to everyday gas to get to work..I could have hung on to my much nicer home had I had put a little bit here and there on my credit card hoping things would get better….Bet theres alot of people that took that route.

“How many billions were poured into commodities by traders in Jan 2008? Not a word here about that – how soon we forget.”

Anon…i don’t know if you are referring to this specific post, but this blog has covered this exhaustively…here’s one that was ~2 months before the bubble popped(use the tags on the right, “commodities” for instance).

Ruetheday: “you’ll see that oil has traded between $20-$40 in todays dollars for almost all of modern history.”

I’m in your camp as i’m always skeptical of new pricing “regimes.” Mean reversion is a powerful economic series.

however, i do agree with their observation that: “oil markets are lagging the macroeconomists in understanding the severity of the economic outlook…As they catch up, and as the full extent of the demand weakness becomes clear, we expect prices to move lower.”

Back to anon’s point about speculation…i think its caused a lot of investors to extrapolate unsustainable demand trends into perpetuity.

I’m not going to get into the supply side, but Badanov summed it up well with occam’s razor and the statement: “So the fevered realization of peak oil will remain for the foreseeable future, just that: a fevered scenario which has yet to play out, and may well never play out in our lifetimes.”